Jordan: There is a fair amount of pent-up velocity in the market, and it will come to market over the next few quarters, irrespective of whether credit is easier to obtain. It’s simply driven
by the need of the owners to access the equity that’s trapped in
those assets.
Martocci: It is difficult to see any real positive change in the lending environment over the next six to 12 months. It is quite possible
that the fundamentals (retail and office rents, condo sales) will continue to deteriorate, causing even more skittishness on the part of
lenders experiencing stress in their loan portfolios.
Gallitto: We’re probably going to remain in the state we’re in for a
good six to 12 months. There need to be some overall corrections
to the market before there’s
normalization. To me, normalization means the return of the
CMBS market. However, for
CMBS to return, it will have to
go back to its roots: stabilized
fixed rate loans at moderate
leverage of 75% to 80%, underwriting in place and income streams. For a time,
CMBS lenders started to tread on the commercial banker territory
by providing bridge lending and even construction loans. Unfortunately, they lacked experience or the dedicated asset management
staff to oversee these riskier transactions. Because of this increased
competition, the commercial banks had to lower their underwriting standards to compete for business. Now with the shutdown of
the CMBS and the syndicated loan market, banks’ balance sheets
have become bloated and the amount of capital available is limited.
“Of the deals that had financ-
ing in the first six months of
this year, half were based on
assumption of existing debt.”
ROBERT M. WHITE JR.
Real Capital Analytics
Aside from CMBS coming back, what other things
would you like to see in place to ensure a lending envi-
ronment that’s sustainable in the long term?
White: Stability. The volatility in spreads and in CMBS pricing is
like catching a falling knife. Whether the spreads end up at 50 over
or 100 over, we need them to settle in at some level and the market
will adjust. They’ve been fluctuating so much, and interest rates
have been fairly volatile as well. The other piece is greater clarity in
the economy—are we or are we not in a recession? Is it going to get
worse or better? We’re getting conflicting numbers.
Martocci: At this point, no one is quite sure what a sustainable lending platform that meets the needs of the CRE community will look
like. Certainly, plain vanilla securitization will continue. However,
there is already a movement for banks to retain more of the risk
portion of their securitized assets to give potential investors the comfort that was once provided by a debt rating from a rating agency.
The banks’ soundness and reputation for prudent underwriting will
once again, at least for a certain amount of time, be important.
To achieve some semblance of a working market, there must be
much greater price discovery than we see today, a purging of the
most opaque securities from balance sheets and a subsequent recapitalization that will allow the banking system to invest in growth
rather than just backfill losses. It is unlikely we will achieve this type
of transparency until the residential housing market stops declining.
Jordan: There are greater minds than mine thinking about this same
issue, but it seems to me the underlying problem lies in the disconnect
between those entities engaged in originating the loans and the relative risk of holding that paper long-term. As long as you’ve got a
risk-free environment for originating loans, the inherent checks and
balances of the free market system will not be sufficient. Financial
institutions and originators must do a better job with underwriting
standards and assessing risk more cautiously.
Higgins: There hasn’t been much overbuilding, and this downturn is
going to restrict a lot of new development that was on the drawing
boards. Much of it won’t get done now because of the credit crunch.
Going forward, high-quality deals will always get done at reasonable
leverage levels. This will help stabilize the market in general. Right
now, you’re still seeing a deterioration in commercial real estate val-
ues, which will continue for the
next six to nine months. But
there’s always money for high-
quality deals. The market is
going to take care of itself.
Gallitto: This all started with
the subprime business. But the
real issue is not a liquidity cri-
sis. It’s a confidence crisis. The
bull’s eye of the confidence cri-
sis is the ratings agencies. It started out with the lack of confidence
in the ratings of subprime paper, and because many of the investors
in that paper were the same ones investing in CMBS and other syndicated loans, all of those investors have pulled back.
How that will be cured is still a debate in Washington. What
Wall Street did wasn’t wrong; it was the ratings agencies that need
to be accountable. If you look at Enron, it was the accounting firms
that got their hands slapped, and what ultimately resulted was a
peer-review process. Maybe that’s the direction the agencies need
to pursue.
Federal Reserve chairman Ben Bernanke recently called
for more government oversight. Do you agree?
White: In general, I don’t think so, and we’ll see how the bailout
of AIG turns out. The market, if left alone, will correct itself far
more quickly than can be legislated. It’s amazing how many
counties and jurisdictions are passing laws against condo conversions, three years past the height of the condo-conversion
boom. That’s how long it’s taken them to react to what was going
on three years ago.
Gallitto: Hopefully, it’s more of a threat of oversight that causes the
industry to step up. That doesn’t mean you change the parameters—
that if the ratings agencies do a great job going forward, we won’t
have any more problems. There are still a lot of issues on banks’
balance sheets. A lot of banks overextended themselves and were
very aggressive in their lending practices. The fallout from residential in many markets around the country is going to have a terrible
impact on equity ratio levels with banks.
What would be ideal is if banks had the appropriate equity ratios, so they could just cut off the cancer and let it go. The problem
is that the percentage of bad loans or problem assets can’t be recognized in one fell swoop; the banks would go under. You need
multiple quarters and multiple write-offs over a period of time while
the banks are earning money on other assets, so they can slowly
get to a point where they can move forward.—RENY
